Despite Multiple Frameworks, These Are Steps Companies Should Always Take
Regulation Crowdfunding – The Latest Iteration
Since May 17, the number of regulation crowdfund offerings has increased from 25 to 100, an increase of 300%. Demand for capital has increased from $13.1 million to $58.8 million over that time period. Actual capital committed has increased from $2.9 million to $8.5 million[1].
So we are seeing more deals. 22% of demand for capital was being met back in mid-May. 14.4% of demand for capital is being met at present. Suffice it to say that competition for capital in the regulation crowdfunding market will only increase.
The virtue of regulation crowdfunding is that investors earning less than $200,000 annually with a net worth below $1 million can participate. The promise is that it will open up the target investing audience for issuers.
The drawback is that it could get messy quick. The Securities and Exchange Commission and FINRA limit investors with less than $100,000 in annual income or net worth to invest the greater of $2,000 or 5% of their income in a crowdfund issuer or company per year, and double that to 10% for investors with more than $100,000 in annual income or net worth.
At the maximum $2,000 investment, an issuer raising the maximum of $1 million under regulation crowdfunding could potentially onboard 500 or more investors, which creates reason for pause. Early-stage issuers are typically lean from a management and administrative perspective, with officers wearing multiple hats and the notion of managing and administrating hundreds of investors can be overwhelming tapping critical time and resources it would much rather spend operating the business.
And keeping in mind that the issuer is going to need to raise additional growth capital in a follow-on early round, a bloated shareholder base, potentially consisting of tens if not hundreds of less sophisticated investors can be off-putting to professional investors and hedge-funds which are going to be critical for supplying growth capital in quantities that are necessary. After all, under the current regulation crowdfunding framework, the maximum $1 million raise per year is hardly a model that a growing issuer can adhere to in order to meet its growth requirements in perpetuity. It is going to have to branch out.
The best way to address this challenge is to create a special purpose vehicle (SPV) which consolidates investors and ultimately makes a much cleaner investment into the issuer. The SPV would be treated as a single shareholder of the issuer.
Still, There Are Multiple Options
To be sure, issuers have more options than ever today: Rule 506(b), Rule 506(c), Regulation Crowdfunding, Regulation A (Tier 1), Regulation A+ (Tier 2), Confidentially Submitted Initial Public Offerings and Initial Public Offerings.
To maximize success, both within the context of the current financing and future rounds, corporate boards need to do their diligence and understand the implications of the financing path they choose. In too many cases the context for our initial discussion with entrepreneurs is a discussion about how to unwind poorly thought-out and planned capitalization strategies. A common thread to all of these discussions has been lack of information, lack of experience, unrealistic expectations, and usually a combination of all of these.
But there are a few best practices, which, regardless of the capitalization strategy you choose, will only serve you well:
1. Get your house in order. There are so many analogies here, but the point is, if you want to attract the broadest audience, the housekeeping matters. This really begs all of the following points:
2. Demonstrate a commitment to good corporate governance. You don’t need a large board, but you need a board, and an appropriate level of experience and independence. This matters less when you are not asking for other people’s money. But when you do get to a point where you need other people’s money, sending a message that there is a governance infrastructure in place that will hold you accountable and look out for their interests – “tone at the top”.
3. Financials matter. Your story and vision will only get you so far. At some point early in the process prospective investors will want to understand how you make money, how well you manage money and the economic decision making skills or deficits you have. To the extent your financial statements are current and prepared in accordance with GAAP by a professional you will send a message that you are at least capable of having a serious discussion with prospective investors about these issues.
4. Commit to transparency and disclosure. Be able to demonstrate that you have a shareholder communications plan that is thoughtful and responsive. When you have material developments at your business, disclose, even when the news is bad.. Keeping your investor base informed and in the loop is critical to maintaining support and avoiding fatigue. And maintain a complete, organized, intuitive and up-to-date due diligence room which prospective investors can access when appropriate, and which will also serve as an accessible repository for reference amongst your team members and board.
These are steps you should take, regardless of the capitalization strategy you choose, before day one of your offering. There are never guarantees to success, but taking these steps will dramatically improve your outcome.
So you have determined the transaction structure for your offering and now you are getting set to market your offering:
5. Have a marketing plan.
a. Investment Packaging. These are documents (investor deck, brief, fact sheet) which tell your story, articulate your value proposition and sell your vision and execution strategy. To the extent that you have sufficient budget and resources enabling you to leverage additional digital media (podcasts and videos) to further extend your message and broaden your impact, do it.
b. Build Your Social Network. Don’t assume that the website or portal you choose to host your offering on will be sufficiently trafficked by qualified investors that your offering will be fully subscribed. Take extra steps to extend your presence and network online so that you can inform your network of your offering and where to find it.
c. Blocking and Tackling Still Matters. Put together a plan to identify, quality and present to investors telephonically, through webinar and in-person. Investing in an experienced team of investment professionals that will commit to understanding your business and can work with you to develop, manage and execute a deal road show can make all of the difference in the success of your financing efforts.
d. Understand What You Can and Can’t Do. All general solicitation is not the same. For example, under Rule 506(c) the parameters are pretty darn wide in terms of promotion, but under Regulation Crowdfunding, Issuers can only issue “tombstone” ads and specific limited information. In the former case the solicitation needs to be directed to Accredited Investors only. In the latter, the financial status of your target audience can be substantially broader – just be sure to keep communications on the Regulation Crowdfunding platform. . Under both Tiers of Reg A, general solicitation is ok, and Issuers can also engage in “test-the-waters” communications. And in an IPO setting, general solicitation is permitted only after the registration statement has been publicly filed.
The key takeaways here are (i) that while issuers have unique sets of conditions and requirements which means that there is no one-size-fits-all capitalization strategy; (ii) there are certain things that all issuers should do, and do well, if they are going to maximize their chance for successfully subscribing their offerings and (iii) be sure that you understand the implications of the capitalization strategy that you do end up choosing and that this strategy will not undermine future rounds of capital that you will inevitably need to raise.
[1] Crowdfund Capital Advisors web page accessed September 15, 2016.
